Trying to Buy a Sole Proprietorship, Help Needed

[daez12]

I have what I consider to be a challenging one, but a CPA probably knows the answer immediately: 

Backstory: 

A prospective business partner (person A) and I (person B) are currently trying to figure out the best way to buy up his current business. We are 50/50 partners in a multi-member LLC (let’s call it Holding Company A) that will act as the “buyer.” His portion is owned personally (person A), and my portion is owned by a single member LLC holding company (Hold Company B) 

The “business” we are purchasing is really just a sole proprietorship. However, person A did file for an LLC and has been running money through its bank account. He purchased some equipment new and some used since March of 2021 for a total of 25k, all under his personal name using cash. He’s doing a couple 100k in revenue, and the handshake agreement is that if I purchase his “business” (however that needs to look) for 30k, he’ll transfer all of the assets to Holding Company A and we will share in its business relative to our operating agreement in Holding Company A as 50/50 partners. Essentially, he very much wants a partnership and I do as well, he’s a guy I've known for a long time so I trust him relative to his ambitions for getting “bought out.” In fact, he doesn’t care if it is structured as a balloon payment for 12 months down the line or whatever other terms we see being mutually beneficial. Plan is to make this business a dba under Holding Company A. 

Advice/Guide Needed: 

1. Selling the equipment: 
   1. Would he sell the equipment (with a bill of sale) from himself personally to Holding Company A? 
      1. If so, would he deduct nothing in depreciation for this year? 
      2. Would Holding Company A be able to utilize the 100% depreciation rule for 2021? 
         1. It’s “new to Holding Company A” but he is also personally an owner and member in Holding Company A. 
      3. Does the 100% depreciation rule account for the purchase price of 25k or for the remainder of the useful life of the equipment? 
2. Given the inflow and outflow of cash to his LLC’s bank account, should he file taxes for the LLC or just roll everything under his “Sole Prop.” Of course he paid local students for labor in cash, no 1099 or W2 (this is all stuff I will handle moving forward). 
3. How do we account for the additional 5k past the equipment cost of 25k that Holding Company A is buying? 
4. Lastly, how would you structure this deal if it were you (assuming you wanted to make it happen despite the historic negligence involved)? 
   1. Balloon payment 12 months at 0% interest contingent on distributions from Holding Company A exceeding 30k? Otherwise, remainder to paid via balloon payment in 24 months contigent on the same? 

[Bsch4477]

You are correct that a CPA would have the answers to your questions. I urge you to contact one rather than to depend on the advice of a stranger on the internet. 

[tagteam]

I agree with the added recommendation that you seek local legal counsel and, further, advice from a professional business broker.

@Rick19744 might have something to add as well. 

[Opus 17]

It's not clear to me why you don't simply invest in the business and be added to person A's LLC as a second member.  

The key point for your question on this forum is that the IRS does not recognize the existence of LLCs, since they are state entities.  A single member LLC is taxed the same as a sole proprietorship, and a multi-member LLC is taxed the same as an unincorporated partnership (unless, in either case, the LLC makes an election to be taxed as an S-corporation which is a federal entity).  As a result, this tax forum is really the wrong place to even ask the question. 

So there could be 50 different best ways to become a part owner or "buy in" to this business, and the best place to get advice is from attorneys and CPAs in your own state.  

[daez12]

Absolutely agree, and I appreciate your response. The reason for the complexity is that I want to depreciate the equipment under Holding Company A as well as avoid any liability associated with past business practices for Person A's LLC.

[daez12]

Absolutely agree; truthfully a supporting factor is that the buyout is only for 30k, and I'm trying to seek advice without paying out excessively.

[daez12]

@Rick19744 Any thoughts? Highly motivated to find a way to make this happen.

[Mike9241]

4. Lastly, how would you structure this deal if it were you (assuming you wanted to make it happen despite the historic negligence involved)?
Balloon payment 12 months at 0% interest contingent on distributions from Holding Company A exceeding 30k? Otherwise, remainder to paid via balloon payment in 24 months contigent on the same?

part of this is a financial question. 

you mention "historic negligence" and "handshake agreement". for these reasons see a lawyer.  usually in these situations what is best for one party from a tax standpoint is not the best for the other from a tax standpoint. don't know what you mean by historic negligence but we don't render legal advice.  and many of us have seen handshake agreements go sideways even between those who would trust the other with their lives. 

[Rick19744]

In reading through the facts and comments:

• Just so you understand, for tax purposes your LLC is technically owned by two individuals.  This is due to the fact, that a SMLLC is a disregarded entity for tax purpose; unless an election is made to treat it as an association.
• Based on bullet 1, you don't have a "holding company".  What you are describing as a holding company is "you" for tax purposes.
• Your terminology is not real clear.  You note a "prospective business partner" and then you go on to indicate that you already have an LLC with this individual. 
  • So are you saying that your partner in your LLC has another business that you want to own as well?
• As I am reading through the facts, there can never be a handshake agreement for all parties protection.  Any agreement reached needs to be in writing.
• If I am reading this correctly, and I asked for clarification in bullet 3, you can't structure this as if you are buying the business and then act as if it is owned by the LLC and split the profits 50/50.
• One way this works is if you buy into the "new" business and then you now have a second LLC.
  • This gets complicated as you will most likely have to deal with step up in basis (Section 754) and then maybe built-in gain (Section 704(c)).  Both of these code sections can get complicated and require special bookkeeping and tax allocations.
• The other way is for the current LLC to acquire the business.
  • In this case it gets even more complicated as there will be step up for you but not for your other partner as he won't get step up on assets that he already owned.
• The other issue that hasn't been mentioned is how you arrived at the purchase price.
  • Typically, at least in the acquisitions I have been involved in, the buyer needs to perform some type of business valuation; whether that be based on profitability and factoring in some multiplication factor or based on assets being acquired.
• Honestly, the comments above are only the tip of the iceberg and this question is really beyond the scope of a forum such as this.  There are too many additional facts, scenarios, other questions that are best done through a one on one discussion with a tax professional.  Unfortunately, in the tax world, the actual $$ involved in a transaction such as this, don't make the tax issues any easier.  It's just smaller numbers, but from the IRS' perspective getting the correct tax result is the same.
• Additionally, in looking at the facts, you definitely need to be cognizant of some issues associated with the business you are looking to acquire.  A business paying out cash and no W-2 or 1099 is an open book for significant tax issues and penalties.  This just reinforces that the agreement needs to be in writing that you are buying assets.  This issue in of itself would give me pause, but I could most likely get over it in some type of an asset acquisition structure.
• You need to make an appointment with a tax professional.  Don't be penny wise and pound foolish.  The tax world can be cruel if not careful.

[Critter-3]

https://www.irs.gov/businesses/small-businesses-self-employed/sale-of-a-business

Both the seller and purchaser of a group of assets that makes up a trade or business must use Form 8594 to report such a sale if: goodwill or going concern value attaches, or could attach, to such assets and. the purchaser's basis in the assets is determined only by the amount paid for the assets.

https://www.irs.gov/forms-pubs/about-form-8594